What analysts said about the banking royal commission

Shares in each of the big four banks were posting small gains in early Friday, but there is still plenty investors and analysts do not know about the slated banking royal commission.

Here is some of what sell-side analysts told clients in notes on Friday morning:

Citi

This could be expensive, even before any potential compensation – We estimate the Royal Commission to cost $1.0bn - $1.25bn just for the seven banks under our coverage with a strong likelihood that this Commission will extend beyond February 2019.

And will likely require business plans and investments to be adjusted – We expect that the Major Banks will need to review many current business plans and investments that have been slated over the next two financial years. The distraction to senior management will likely be one of the key risks over the next few years... as details of the Royal Commission are firmed up, we expect we will need to adjust our earnings estimates for each of the banks. It is just too early to be definitive at this stage.

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UBS

The Royal Commission is likely to be expensive and distracting (costs ~$50m-$100m per bank). It is difficult to predict what the final recommendations will be. However, we believe it is in all political parties' interest for the recommendations to be material and lead to cultural change. Further, in the past the banks have used mortgage repricing to offset regulatory headwinds (higher capital, macro prudential and Bank Levy). We think this will become more challenging in a post Royal Commission environment.

The banks have served Australia well for many years and have a high level of customer satisfaction, in our view. However, we believe there is a dislike for banking institutions in the community and a perception they are over-earning. While a Royal Commission may address some of these concerns, the banks still face headwinds if there is a change in Federal Government given the Labor Party's stated policies including: limiting negative gearing; reducing capital gains tax relief; limiting family trusts; higher personal tax rates. We are cautious on Australian banks and prefer other banks in the region.

Deutsche Bank

Overall, today's outcome is less damaging than having the opposition and minor parties dictate the terms of a commission of inquiry. However it is still a negative development given the risk of further conduct issues arising via the inquiry and is likely to weigh on sector valuations.

We expect a Royal Commission will be disruptive for the banks, and will be a distraction for management. There is also risk that further misconduct issues could arise in the course of the inquiry. Ultimately, the Royal Commission could potentially call for compensation schemes for affected consumers, and make recommendations to remedy the causes of the misconduct it finds. It remains to be seen how far-reaching these recommendations may be, and they could impose new constraints on the banks' operations.

Macquarie

While another significant regulatory inquiry is hardly a positive outcome for the sector, in our view it was inevitable. Moreover, we believe that the terms of reference under the current government are likely to be more constructive, measured and timely (interim report due in September 2018). While today's announcement has arguably reduced regulatory uncertainty, we recognise the risk of the final terms of reference being broadened and future inquiries even after the Royal Commission is completed.

While the terms of reference are likely to cover the broader financial services offering, we believe predominate focus will be on consumer and SME customers and offerings. In this context, we expect all of the majors to be broadly similarly impacted with ANZ being a potential relative beneficiary given its overweight position to institutional business.

JPMorgan

Unsurprisingly, there was a negative initial impact on share prices, but the downside appears limited given the narrow focus of the inquiry and short timeframe involved.

Terms of reference – The draft terms of reference released by the government are fairly narrowly defined and relate largely to misconduct by financial institutions. Of note, there is no mention of potential issues around vertical integration – currently being considered by the Productivity Commission – which would seem to lower the risk of forced divestments by the banks of their wealth management arms.

Implications for bank stocks – Overall, we were not surprised by the announcement given public opinion and political pressures at play. The Royal Commission will be negative for sentiment and will add to costs, which are both difficult to quantify, but the narrow terms of reference should limit some of the downside.

Goldman Sachs

Identifiable near-term risks for the banks include elevated expenses, management distraction and broader uncertainty regarding outcomes. Despite the sector now facing elevated risks in light of the Royal Commission, its PER relative to non-bank industrials implies a risk discount that is only consistent with the historic average. We therefore think that discount to non-bank industrials (currently c.-30%) may continue to widen. We continue to prefer ANZ (Buy, on CL).